September 30, 2012 at 10:54 pm #17160ellis_andrew598Member
In my microeconomics course a few days ago my professor was discussing elasticity of demand for products and put forth the case for price supports of agricultural products. His reasoning was that food has a largely inelastic demand, and over time agricultural products will become cheaper to produce due to technology, better fertilizers, etc. As a result, these prices will drop but because demand for food is inelastic consumers will not purchase more and more produce as the prices continue to fall, so farmers’ income will eventually reach such a point where it is impossible to make a living as a producer of food. He even went so far as to say the dairy market would have disappeared fifty years ago without intervention.
My problem was that it seemed as though he were lumping all food together. Food is not homogeneous and so demand for individual products is elastic. For example, if the price of beef drops people will buy more hamburger and steaks to eat. However, if the prices rise consumers will then purchase chicken or pork. In the case of dairy products consumers will purchase less yogurt, ice cream, or cheese. Perhaps, they’ll even try soy milk. So, it seems as though farmers could diversify their production or simply change as demand changes to ensure profitability. Is this idea correct or is my professor correct in his view?October 1, 2012 at 2:39 am #17161miljacicMember
So what would happen, really, if farmers couldn’t live on making food anymore? So, farmers would stop making it and food would disappear from the system.. yet magically prices would still be the same? Would people be crawling around starving and begging for a snack yet not be willing to pay some more for it? Obviously that elasticity is not a constant.. if things change it changes too.
Analogy from Physics: a rubber ball is soft and bouncy seemingly all the time, round the clock, every day, all summer long. But change conditions, let’s say, freeze it up. It will get brittle, won’t bounce but break to pieces.
Anyway, even inanimate objects, like the rubber ball, can respond dramatically to new conditions, not to speak of human beings and something as important as food.October 1, 2012 at 8:29 am #17162ellis_andrew598Member
Thanks, I thought it was pretty absurd to assume an entire market would disappear but the demand would still remain.October 1, 2012 at 1:45 pm #17163jmherbenerModerator
Apart from the fallacy of assuming that the demand curve for food is constant under changing conditions, your professor’s conclusion does not follow from his stipulations.
If an entrepreneur is selling a product at a price for which demand is inelastic, he can raise his price and increase his revenues even though he sells less output. No entrepreneur will price his product in the inelastic portion of his demand curve. Instead, regardless of how steep or flat the demand curve is for his product, he will price it at the unit elastic point (which is the midpoint) of his (linear) demand curve. At that point, his revenues will be as large as possible.
If the farmer’s costs are falling as he raises his price to take advantage of the inelastic demand, then his profit will skyrocket. As a consequence, other entrepreneurs will invest in farming and production will increase. Increased production by more entrepreneurs will reduce the demand curves for existing farmers and they will lower their prices to render the greatest revenue under the new conditions. This process of adjustment will continue until there is no more additional profit to be earned by further expansion in production.
Moreover, technology is not a force of nature that automatically lower costs. A particular technology is chosen by entrepreneurs as efficient, given his circumstances. New technologies are brought forth by saving-investing in research and development. Entrepreneurs will only invest in technologies that they anticipate will render their production more profitable.
Elasticity is discussed in the lecture on Competition and Monopoly.
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